At a meeting on Thursday of the SEC’s Investor Advisory Committee, a panel discussed the declining number of IPOs, a topic that seems to be top of mind for many in the securities arena. Of course, there’s a reason for that; according to a panelist from EY, there were about 8,000 public companies in 1996, but only about 4,000 now. What happened?

(The following is based solely on notes, so standard caveats apply.) According to EY, what happened—largely the result of acquisitions and delistings—happened primarily by 2002; it’s not just a recent phenomenon. And much of the decline may reflect the popping of the dot-com bubble in the first years of the new millennium. Accordingly, some would argue that a number of those companies should not have gone public in the first place and that measuring against the height of the bubble is wrong-headed.

What’s more, the characteristics of IPOs are different now than they were in 1996. Now, according to one panelist, the average size of an IPO is $192M compared with only $62M in the earlier period. Currently, the panelists seemed to agree, the primary reasons for IPOs are investor liquidity, reputation building and price discovery, as well as, one panelist noted, the desire to use publicly tradable stock for acquisitions, while a couple of decades earlier, the primary motive was capital-raising. (This shift might explain the recent interest in direct listings—initial listings that do not involve underwritten capital-raising offerings).

There has also been a significant extension of the timeframe to IPO. One panelist observed that, in the past, the typical time to IPO was six to seven years, whereas now the timeframe is closer to ten to eleven years. As a result, he contended, more appreciation in value tends to accrue to private holders and less to public investors as companies go public at much higher valuations and do not experience post-IPO stock price growth at the same multiples as in the past. As examples, the panelist compared two highly successful companies, one that went public two decades ago and now has a market cap a thousand times its IPO valuation, almost all of which accrued to the public investors, and another which, 15 years later, had an enormous valuation upon going public, all of which accrued to its private investors, but now has a market cap only four times bigger.

One panelist reported that, when a number of CFOs were asked why they would decide not to go public, at the top of the list was the need to maintain decision-making control. In the private market, another panelist suggested, companies and investors have a kind of unspoken “pact” about long-term strategy. But, said one panelist, the rise of hedge-fund activism in tech and other product-cycle-driven public companies—a relatively recent phenomenon—has fueled concerns among founders and other management that they will be hampered in pursuing long-term strategic goals by activists with short-term perspectives. These companies fear that activity that may have significant long-term payout, but a near-term adverse price impact (e.g., M&A activity, change in product strategy, substantial investment in R&D), will draw scrutiny and intervention from hedge-fund opportunists. Hence, the recent prevalence of dual-class capital structures, which one panelist characterized as merging some private company benefits into a public company structure. Perhaps dual-class structures are a blunt instrument, the panelist indicated, but it’s one tool that is available. (Dual-class structures were discussed by the Committee in March. See this PubCo post and this PubCo post.) Tenure-based voting was suggested by a VC panelist as another possible remedy.

SideBar: Tenure voting, discussed in this PubCo post from 2015, is a technique resurrected from the 1980s that some believe could be used to repel hedge-fund activists and other short-termers. The concept would give investors additional votes if they hold their shares for at least a specified period of time, thus rewarding long-term holders by giving them more say in the future of the company than, say, short-term hedge fund activists that may favor short-term profits over long-term business strategies. The concept was reportedly invented during the 1980s in response to a wave of hostile takeover attempts. Perhaps the first company to implement this approach was J.M. Smucker Co., which adopted a tenure voting plan as a shareholder protection measure. Under the plan, existing shareholders received ten votes for each share held. However, upon transfer, these shares would revert to one vote per share, but would regain super-voting status if they were held for 48 consecutive months. In 1996, in Williams v. Geier, the Delaware Supreme Court upheld adoption by the board of a similar plan as a proper exercise of the business judgment rule to promote long-term planning (even though the effect of the plan was to concentrate voting rights in hands of a controlling block); the plan was then approved by a fully informed shareholder vote, which was considered dispositive.

At the bottom of the CFO list of reasons not to go public was the burden of regulatory compliance. As one academic on the panel explained, while regulatory cost has been the dominant narrative, that narrative ignores the impact of deregulation of private-capital raising—it’s now much easier not only to raise private capital (e.g., changes to Reg D) but also to stay private (e.g., changes to the Exchange Act registration threshold). With low interest rates, debt has also been an attractive option for funding in lieu of an IPO. In addition, markets have provided more opportunities for liquidity through secondary trading of privately held shares. The panelist also argued that private companies enjoy the benefit of information asymmetry relative to public companies, which are subject to much more significant disclosure requirements.

The decline in IPOs has been disproportionately pronounced for smaller cap companies. Post-IPO performance can be a bit of lottery, said one panelist, and performance for some smaller companies can be disappointing. Many smaller companies have a harder time as public companies, suffering from significantly less research and fewer market makers, resulting in more difficulty in raising capital and less liquidity.

SideBar: According to one panelist, the upcoming revision in the EU to the Markets in Financial Instruments directive (MiFID II), which will require the disclosure of the amount of commission payment used for research, could further reduce the levels of research for smaller companies, as there will be an interest in showing lower research expenses.

One anomaly, according to one panelist, has been the biotech market, where smaller cap companies need significant capital and are successfully able to access the public markets for multiple rounds.

Changes in the market were also raised as a cause for the decline. There may be less demand for IPOs because of the growth of passive index funds, which, by definition, do not invest in IPOs, as well as, panelists suggested, the underperformance of some smaller cap IPOs. Panelists also noted a lack of liquidity in the small cap market.

SideBar: The views discussed at the Committee meeting largely echo those expressed at the May “Dialogue on Reviving the U.S. IPO Market,” hosted by the SEC and NYU’s Salomon Center for the Study of Financial Institutions. In that forum, the substantial decline in IPOs, particularly IPOs of small-cap companies, was likewise noted. In his remarks, Commissioner Michael Piwowar observed that,

“since 2000, the average annual number of IPOs is 135—less than one-third the average annual number of IPOs—457—in the 1990s. This decline has occurred despite the fact that there has been no downward trend in the creation of new companies over the same period. Traditional economic factors, such as fluctuations in companies’ demand for capital and changes in investor sentiment, also cannot explain the large decrease….The substantial drop in the number of IPOs in the United States is primarily driven by the disappearance of small IPOs. In the 1980s and 1990s, IPOs with proceeds of less than $30 million constituted approximately 60 percent and 30 percent, respectively, of all IPOs. In fact, some of the most iconic and innovative U.S. companies… entered the public market as small IPOs. This trend reversed in the 2000s. IPOs with proceeds less than $30 million accounted for only 10 percent of all IPOs in the period 2000-2015. By comparison, large IPOs have increased from 13 percent in the 1990s to approximately 45 percent of all IPOs since then.”

Downplaying the concern to some extent, several panelists participating in the dialogue attributed the decline primarily to extension of the timeframe for going public: now, there is more concern with forcing companies to go public too early, and less mature companies tend not to be on the receiving end of calls from investment banks, as they may not yet be considered to be the caliber of company necessary to satisfy current market expectations. Ultimately, however, one panelist opined, the expectation for most VC-backed companies is that they are headed toward a liquidity event, whether through an IPO or an M&A event. In addition, one panelist, suggested, a more “vibrant ecosystem” was needed to support smaller companies. As at the Committee meeting above, several panelists agreed that, while regulation was often discussed as an issue, it was really marginal as a factor in the decision of whether to stay private. Several panelists also noted that one problem afflicting public companies is short-term pressure for quarterly results, particularly for companies in industries where share prices are most sensitive to earnings news. It was noted that one response to the fear of short-termism and hedge fund activism was the dual-class capital structure, which one panelist facetiously termed the “new bad boy of corporate governance.” The recommendation there was “to allow private ordering to figure it out.”

Among the suggestions to address these issues were increasing research and market activities for small cap companies through subsidies, improving liquidity by reducing the number of trading venues, continuing the tic-size pilot, reducing the concentration cap at funds and requiring transparency in short positions. Other suggestions seemed unlikely to gain popularity, such as reinstating restrictions on private capital-raising activity, eliminating disclosure asymmetry by increasing private company disclosure and reversing JOBS Act provisions to prevent companies from staying private as long.